Note 5. Loans and the Allowance for Loan Losses

Loans are stated at their principal amounts inclusive of net deferred loan origination fees. Interest income is credited as earned except when a loan becomes past due 90 days or more and doubt exists as to the ultimate collection of interest or principal; in those cases the recognition of income is discontinued. Loans that are past due 90 days or more that are both well secured and in the process of collection will remain on an accruing basis. When a loan is placed on non-accrual status, interest accruals cease and uncollected accrued interest is reversed and charged against current income.

Portfolio segments are defined as the level at which an entity develops and documents a systematic methodology to determine its Allowance. Management has determined that the Corporation has two portfolio segments of loans and leases (commercial and consumer) in determining the Allowance. Both quantitative and qualitative factors are used by management at the portfolio segment level in determining the adequacy of the Allowance for the Corporation. Classes of loans and leases are a disaggregation of a Corporation's portfolio segments. Classes are defined as a group of loans and leases which share similar initial measurement attributes, risk characteristics, and methods for monitoring and assessing credit risk. Management has determined that the Corporation has five classes of loans and leases commercial and industrial (including lease financing), commercial — real estate, construction, residential mortgage (including home equity) and installment.

Generally, all classes of commercial and consumer loans and leases are placed on non-accrual status upon becoming contractually past due 90 days or more as to principal or interest (unless loans and leases are adequately secured by collateral, are in the process of collection, and are reasonably expected to result in repayment), when terms are renegotiated below market levels, or where substantial doubt about full repayment of principal or interest is evident. For certain installment loans the entire outstanding balance on the loan is charged-off when the loan becomes 60 days past due.

Payments received on non-accrual loans are applied against principal. A loan may only be restored to an accruing basis when it again becomes well secured and in the process of collection or all past due amounts have been collected and six months of payments to demonstrate that the borrower can continue to meet the loan terms. Loan origination fees and certain direct loan origination costs are deferred and recognized over the life of the loan as an adjustment to the loan's yield using the level yield method.

Impaired Loans

The Corporation accounts for impaired loans in accordance with FASB ASC 310-10-35. The value of impaired loans is based on the present value of expected future cash flows discounted at the loan's effective interest rate or, as a practical expedient, at the loan's observable market price or at the fair value of the collateral if the loan is collateral dependent.

The Corporation has defined its population of impaired loans to include all non-accrual and troubled debt restructuring loans. As part of the evaluation of the value of impaired loans, the Corporation reviews all non-homogeneous loans in each instance above an established dollar threshold of $200,000 for impairment internally classified as substandard or below. Smaller impaired non-homogeneous loans and impaired homogeneous loans are not measured for specific reserves and are covered under the Corporation's general reserve.

A loan is considered impaired when, based on current information and events, it is probable that the Corporation will not be able to collect all amounts due from the borrower in accordance with the contractual terms of the loan, including scheduled interest payments. Impaired loans include all classes of commercial and consumer non-accruing loans and all loans modified in a troubled debt restructuring ("TDR").

When a loan has been identified as being impaired, the amount of impairment is measured based on the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's observable market price, or the estimated fair value of the collateral, less any selling costs, if the loan is collateral-dependent. If the measurement of the impaired loan is less than the recorded investment in the loan (including accrued interest, net of deferred loan fees or costs and unamortized premiums or discounts), an impairment is recognized by creating or adjusting an existing allocation of the Allowance, or by recording a partial charge-off of the loan to its fair value. Interest payments made on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest income may be accrued or recognized on a cash basis.

Loans Modified in a Troubled Debt Restructuring

Loans are considered to have been modified in a TDR when due to a borrower's financial difficulties, the Corporation makes certain concessions to the borrower that it would not otherwise consider. Modifications may include interest rate reductions, principal or interest forgiveness, forbearance, and other actions intended to minimize economic loss and to avoid foreclosure or repossession of collateral. Generally, a non-accrual loan that has been modified in a TDR remains on non-accrual status for a period of six months to demonstrate that the borrower is able to meet the terms of the modified loan. However, performance prior to the modification, or significant events that coincide with the modification, are included in assessing whether the borrower can meet the new terms and may result in the loan being returned to accrual status at the time of loan modification or after a shorter performance period. If the borrower's ability to meet the revised payment schedule is uncertain, the loan remains on non-accrual status.

Reserve for Credit Losses

The Corporation's reserve for credit losses is comprised of two components, the allowance and the reserve for unfunded commitments (the "Unfunded Commitments").

Allowance for Loan Losses

The allowance for loan losses is maintained at a level determined adequate to provide for probable loan losses. The allowance is increased by provisions charged to operations and reduced by loan charge-offs, net of recoveries. The allowance is based on management's evaluation of the loan portfolio considering economic conditions, the volume and nature of the loan portfolio, historical loan loss experience and individual credit situations.

Material estimates that are particularly susceptible to significant change in the near-term relate to the determination of the allowance for loan losses. In connection with the determination of the allowance for loan losses, management obtains independent appraisals for significant properties.

The ultimate collectability of a substantial portion of the Bank's loan portfolio is susceptible to changes in the real estate market and economic conditions in the State of New Jersey and the impact of such conditions on the creditworthiness of the borrowers.

Management believes that the allowance for loan losses is adequate. Management uses available information to recognize loan losses; however, future additions to the allowance may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank's allowance for loan losses. Such agencies may require the Bank to recognize additions to the allowance based on their judgments about information available to them at the time of their examinations.

Reserve for Unfunded Commitments

The reserve for unfunded commitments is maintained at a level believed by management to be sufficient to absorb estimated probable losses related to unfunded credit facilities and is included in other liabilities in the consolidated statements of condition. The determination of the adequacy of the reserve is based upon an evaluation of the unfunded credit facilities, including an assessment of historical commitment utilization experience, and credit risk. Net adjustments to the reserve for unfunded commitments are included in other expense.

Composition of Loan Portfolio

The following table sets forth the composition of the Corporation's loan portfolio, including net deferred fees and costs, at March 31, 2012 and December 31, 2011:


	March 31, 2012		December 31, 2011
	(Dollars in Thousands)
Commercial and industrial	$	171,630	$	146,711
Commercial real estate		425,855		408,164
Construction		34,093		39,388
Residential mortgage		158,600		160,771
Installment		385		959
Subtotal		790,563		755,993
Net deferred loan costs		59		17
Total loans	$	790,622	$	756,010

At March 31, 2012 and December 31, 2011, loans to executive officers and directors aggregated approximately $20,053,000 and $10,279,000, respectively. During the quarter ended March 31, 2012, the Corporation made new loans to executive officers and directors in the amount of $5,000; payments by such persons during 2012 aggregated $141,000. On March 30, 2012, the Corporation appointed Frederick S. Fish to the Board of Directors. Mr. Fish had a prior lending relationship with the Bank, and as of March 31, 2012, total loans to Mr. Fish were approximately $9,910,000.

Management is of the opinion that the above loans were made on the same terms and conditions as those prevailing for comparable transactions with non-related borrowers.

At March 31, 2012 and December 31, 2011, loan balances of approximately $495.8 million and $469.5 million, respectively, were pledged to secure short term borrowings from the Federal Reserve Bank of New York and Federal Home Loan Bank Advances.

The following table presents information about loan receivables on non-accrual status at March 31, 2012 and December 31, 2011:

Loans Receivable on Non-Accrual Status


	March 31, 2012		December 31, 2011
	(Dollars in Thousands)
Commercial and industrial	$	245	$	125
Commercial real estate		408		225
Construction		3,044		3,044
Residential mortgage		3,428		3,477
Total loans receivable on non-accrual status	$	7,125	$	6,871

The amount of interest income that would have been recorded on non-accrual loans during the three months ended March 31, 2012 and the year ended December 31, 2011, had payments remained in accordance with the original contractual terms, was $61,000 and $378,000, respectively.

The Corporation continuously monitors the credit quality of its loans receivable. In addition to the internal staff, the Corporation utilizes the services of a third party loan review firm to rate the credit quality of its loans receivable. Credit quality is monitored by reviewing certain credit quality indicators. Assets classified "Pass" are deemed to possess average to superior credit quality, requiring no more than normal attention. Assets classified as "Special Mention" have generally acceptable credit quality yet possess higher risk characteristics/circumstances than satisfactory assets. Such conditions include strained liquidity, slow pay, stale financial statements, or other conditions that require more stringent attention from the lending staff. These conditions, if not corrected, may weaken the loan quality or inadequately protect the Corporation's credit position at some future date. Assets are classified "Substandard" if the asset has a well defined weakness that requires management's attention to a greater degree than for loans classified special mention. Such weakness, if left uncorrected, could possibly result in the compromised ability of the loan to perform to contractual requirements. An asset is classified as "Doubtful" if it is inadequately protected by the net worth and/or paying capacity of the obligor or of the collateral, if any, that secures the obligation. Assets classified as doubtful include assets for which there is a "distinct possibility" that a degree of loss will occur if the inadequacies are not corrected. All loans past due 90 days or more and all impaired loans are included in the appropriate category below. The following table presents information, including deferred fees and costs, about the loan credit quality at March 31, 2012 and December 31, 2011:

Credit Quality Indicators


	March 31, 2012 (Dollars in Thousands)
	Pass		Special Mention		Substandard		Doubtful		Total
Commercial and industrial	$	167,539	$	2,568	$	1,523	$	—	$	171,630
Commercial real estate		397,528		15,810		12,517		—		425,855
Construction		31,049		—		3,044		—		34,093
Residential mortgage		151,708		393		6,499		—		158,600
Installment		385		—		—		—		385
Total loans	$	748,209	$	18,771	$	23,583	$	—	$	790,563

Credit Quality Indicators


	December 31, 2011 (Dollars in Thousands)
	Pass		Special Mention		Substandard		Doubtful		Total
Commercial and industrial	$	143,097	$	2,022	$	1,592	$	—	$	146,711
Commercial real estate		371,519		24,282		12,363		—		408,164
Construction		36,344		—		3,044		—		39,388
Residential mortgage		155,098		—		5,673		—		160,771
Installment		959		—		—		—		959
Total loans	$	707,017	$	26,304	$	22,672	$	—	$	755,993

The following table provides an analysis of the impaired loans at March 31, 2012 and December 31, 2011:


	March 31, 2012 (Dollars in Thousands)
No Related Allowance Recorded	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
Commercial real estate	$	2,100	$	2,549		$—	$	2,105		$30
Total	$	2,100	$	2,549	$	—	$	2,105	$	30


With An Allowance Recorded	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
Commercial real estate	$	4,180	$	4,180	$	549	$	4,180	$	35
Construction		3,044		3,584		200		3,044		—
Residential mortgage		4,062		4,062		329		4,469		26
Total	$	11,286	$	11,826	$	1,078	$	11,693	$	61
Total
Commercial real estate	$	6,280	$	6,729	$	549	$	6,285	$	65
Construction		3,044		3,584		200		3,044		—
Residential mortgage		4,062		4,062		329		4,469		26
Total (including related allowance)	$	13,386	$	14,375	$	1,078	$	13,798	$	91


	December 31, 2011 (Dollars in Thousands)
No Related Allowance Recorded	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
Commercial and industrial	$	—	$	—	$	—	$	292	$	11
Commercial real estate		2,121		2,570		—		3,390		149
Construction		—		—		—		3,156		—
Total	$	2,121	$	2,570	$	—	$	6,838	$	160


With An Allowance Recorded	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
Commercial real estate	$	4,180	$	4,180	$	567	$	4,583	$	258
Construction		3,044		3,584		200		3,048		18
Residential mortgage		4,601		4,601		318		4,572		102
Total	$	11,825	$	12,365	$	1,085	$	12,203	$	378
Total
Commercial and industrial	$	—	$	—	$	—	$	292	$	11
Commercial real estate		6,301		6,750		567		7,973		407
Construction		3,044		3,584		200		6,204		18
Residential mortgage		4,601		4,601		318		4,572		102
Total (including related allowance)	$	13,946	$	14,935	$	1,085	$	19,041	$	538

The Corporation defines an impaired loan as a loan for which it is probable, based on information available at the determination date, that the Corporation will not collect all amounts due under the contractual terms of the loan. At March 31, 2012, impaired loans were primarily collateral dependent, and totaled $13.4 million. Specific allowance for loan loss of $1.1 million was assigned to impaired loans of $11.3 million. Loans in the amount of $2.1 million had no specific allowance allocation. At March 31, 2011, average impaired loans were 16.7 million and related interest income recognized was $64,000.

Loans are considered to have been modified in a troubled debt restructuring when due to a borrower's financial difficulties, the Corporation makes certain concessions to the borrower that it would not otherwise consider. Modifications may include interest rate reductions, principal or interest forgiveness, forbearance, and other actions intended to minimize economic loss and to avoid foreclosure or repossession of collateral. Generally, a non-accrual loan that has been modified in a troubled debt restructuring remains on non-accrual status for a period of six months to demonstrate that the borrower is able to meet the terms of the modified loan. However, performance prior to the modification, or significant events that coincide with the modification, are included in assessing whether the borrower can meet the new terms and may result in the loan being returned to accrual status at the time of loan modification or after a shorter performance period. If the borrower's ability to meet the revised payment schedule is uncertain, the loan remains on non-accrual status. Included in impaired loans at March 31, 2012 are loans that are deemed troubled debt restructurings. Of these loans, $6.9 million, 79.7% of which are included in the tables above, are performing under the restructured terms and are accruing interest.

The following table provides an analysis of the aging of loans, excluding deferred fees and costs that are past due at March 31, 2012 and December 31, 2011:

Aging Analysis


	March 31, 2012 (Dollars in Thousands)
	30 – 59 Days Past Due		60 – 89 Days Past Due		Greater Than 90 Days		Total Past Due		Current		Total Loans Receivable		Loans Receivable > 90 Days And Accruing
Commercial and Industrial	$	1,441	$	32	$	245	$	1,718	$	169,912	$	171,630	$	—
Commercial Real Estate		—		15		1,438		1,453		424,402		425,855		1,030
Construction		—		—		3,044		3,044		31,049		34,093		—
Residential Mortgage		2,371		48		3,460		5,879		152,721		158,600		32
Installment		4		—		—		4		381		385		—
Total	$	3,816	$	95	$	8,187	$	12,098	$	778,465	$	790,563	$	1,062


	December 31, 2011 (Dollars in Thousands)
	30 – 59 Days Past Due		60 – 89 Days Past Due		Greater Than 90 Days		Total Past Due		Current		Total Loans Receivable		Loans Receivable > 90 Days And Accruing
Commercial and Industrial	$	137	$	1,544	$	125	$	1,806	$	144,905	$	146,711	$	—
Commercial Real Estate		1,331		5,335		1,254		7,920		400,244		408,164		1,029
Construction		—		—		3,044		3,044		36,344		39,388		—
Residential Mortgage		2,174		99		3,477		5,750		155,021		160,771		—
Installment		16		—		—		16		943		959		—
Total	$	3,658	$	6,978	$	7,900	$	18,536	$	737,457	$	755,993	$	1,029

The following table details the amount of loans receivable that are evaluated individually, and collectively, for impairment, and the related portion of the allowance for loan loss that is allocated to each loan portfolio segment:

Allowance for loan and lease losses


	March 31, 2012 (Dollars in Thousands)
	C & I		Comm R/E		Construction		Res Mtge		Installment		Unallocated		Total
Allowance for loan and lease losses:
Individually evaluated for impairment	$	—	$	549	$	200	$	329	$	—	$	—	$	1,078
Collectively evaluated for impairment		1,784		5,327		437		905		54		169		8,676
Total	$	1,784	$	5,876	$	637	$	1,234	$	54	$	169	$	9,754
Loans Receivable
Individually evaluated for impairment	$	1,021	$	12,634	$	3,044	$	4,511	$	—	$	—	$	21,210
Collectively evaluated for impairment		170,609		413,221		31,049		154,089		385		—		769,353
Total	$	171,630	$	425,855	$	34,093	$	158,600	$	385	$	—	$	790,563

Allowance for loan and lease losses


	December 31, 2011 (Dollars in Thousands)
	C & I		Comm R/E		Construction		Res Mtge		Installment		Unallocated		Total
Allowance for loan and lease losses:
Individually evaluated for impairment	$	—	$	567	$	200	$	318	$	—	$	—	$	1,085
Collectively evaluated for impairment		1,527		5,405		507		945		51		82		8,517
Total	$	1,527	$	5,972	$	707	$	1,263	$	51	$	82	$	9,602
Loans Receivable
Individually evaluated for impairment	$	953	$	12,769	$	3,044	$	5,050	$	—	$	—	$	21,816
Collectively evaluated for impairment		145,758		395,395		36,344		155,721		959		—		734,177
Total	$	146,711	$	408,164	$	39,388	$	160,771	$	959	$	—	$	755,993

The Corporation's allowance for loan losses is analyzed quarterly. Many factors are considered, including growth in the portfolio, delinquencies, nonaccrual loan levels, and other factors inherent in the extension of credit. There have been no material changes to the allowance for loan loss methodology as disclosed in the Corporation's Annual Report on Form 10-K for the year ended December 31, 2011.

A summary of the activity in the allowance for loan losses is as follows:


	Three Months Ended March 31, 2012 (Dollars in Thousands)
	C & I		Comm R/E			Construction			Res Mtge			Installment			Unallocated		Total
Balance at January 1,	$	1,527	$	5,972		$	707		$	1,263		$	51		$	82	$	9,602
Charge offs		—		—			—			—			(3	)		—		(3	)
Recoveries		—		—			—			47			1			—		48
Provision		257		(96	)		(70	)		(76	)		5			87		107
Balance at March 31,	$	1,784	$	5,876		$	637		$	1,234		$	54		$	169	$	9,754


	Three Months Ended March 31, 2011 (Dollars in Thousands)
	C & I			Comm R/E		Construction		Res Mtge			Installment			Unallocated			Total
Balance at January 1,	$	1,272		$	5,715	$	551	$	1,038		$	52		$	239		$	8,867
Charge offs		(165	)		—		—		(23	)		(3	)		—			(191	)
Recoveries		35			—		—		—			2			—			37
Provision		236			468		349		(63	)		—			(112	)		878
Balance at March 31,	$	1,378		$	6,183	$	900	$	952		$	51		$	127		$	9,591

At March 31, 2012, there were no commitments to lend additional funds to borrowers whose loans were on non-accrual status or were contractually past due in excess of 90 days and still accruing interest.

The policy of the Corporation is to generally grant commercial, mortgage and installment loans to New Jersey residents and businesses within its market area. The borrowers' abilities to repay their obligations are dependent upon various factors, including the borrowers' income and net worth, cash flows generated by the borrowers' underlying collateral, value of the underlying collateral, and priority of the lender's lien on the property. Such factors are dependent upon various economic conditions and individual circumstances beyond the control of the Corporation. The Corporation is therefore subject to risk of loss. The Corporation believes its lending policies and procedures adequately minimize the potential exposure to such risks and that adequate provisions for loan losses are provided for all known and inherent risks. Collateral and/or personal guarantees are required for virtually all loans.

The following table presents information about the troubled debt restructurings (TDRs) by class for the period indicated:


	Three Months Ended March 31, 2012
	Number of Loans		Pre-restructuring Outstanding Recorded Investment		Post-restructuring Outstanding Recorded Investment
	(Dollars in Thousands)
Troubled debt restructurings:
Commercial Real Estate		1	$	225	$	225
Residential Mortgage		1		714		711
Total		2	$	939	$	936

The Corporation charged off $3,000 in connection with loan modifications at the time of the modification during the three months ended March 31, 2012.

The Corporation had no loan modified as a TDR within the previous twelve months that subsequently defaulted during the three months ended March 31, 2012.

The Corporation adopted ASU No. 2011-02 on July 1, 2011 which provides additional guidance to creditors for evaluating whether a modification or restructuring of a receivable is a troubled debt restructuring. In general, a modification or restructuring of a loan constitutes a TDR if the Corporation grants a concession to a borrower experiencing financial difficulty. Loans modified in TDRs are placed on non-accrual status until the Corporation determines that future collection of principal and interest is reasonably assured, which generally requires that the borrower demonstrate performance according to the restructured terms for a period of at least six months. However, performance prior to the modification, or significant events that coincide with the modification, are included in assessing whether the borrower can meet the new terms and may result in the loan being returned to accrual status at the time of loan modification or after a shorter performance period. If the borrower's ability to meet the revised payment schedule is uncertain, the loan remains on non-accrual status.

Loans modified in a troubled debt restructuring totaled $11.5 million at March 31, 2012 of which $4.6 million were on non-accrual status. The remaining loans modified were current at the time of the restructuring and have complied with the terms of their restructure agreement. At December 31, 2011, loans modified in a troubled debt restructuring totaled $11.1 million of which $3.7 million were on non-accrual status. The remaining loans modified were current at the time of the restructuring and have complied with the terms of their restructure agreement.

In an effort to proactively manage delinquent loans, the Corporation has selectively extended to certain borrowers concessions such as rate reductions, extension of maturity dates, principal or interest forgiveness, adjusted repayment terms, forbearance agreements, or combinations of two or more of these concessions. As of March 31, 2012, loans on which concessions were made with respect to adjusted repayment terms amounted to $1.6 million. Loans on which combinations of two or more concessions were made amounted to $9.8 million. The concessions granted included principal concessions, rate reduction, adjusted repayment, extended maturity and payment deferral.